Loan defects are inching upward in a market where higher rates could lead to more fraud risk.

The frequency of defects, fraud and misrepresentation in information submitted for loan applications in February was up 1.3% year to year and by 4.1% from the previous month, according to an index released by First American Financial Corp. in Santa Ana, Calif.

Purchase defects are up 2.4% on both a consecutive-month and year-over-year basis. Refi defects are 6.2% lower than a year ago, but up 3.4% from last month.

"Rising mortgage rates continue to increase the share of higher risk purchase loan applications, but they are also incenting more borrowers to apply for ARMs," said First American Chief Economist Mark Fleming in a press release.

"The savings for the customer can be significant, but ARM loan applications have historically had higher defect, misrepresentation and fraud risk."

The ARM share of applications during the week ending March 24 was 8.5%, according to the Mortgage Bankers Association's index.

The most prevalent type of ARM, a loan that initially has a five-year fixed-rate period before adjusting years, in February has had a rate 1% lower than a traditional fixed rate mortgage.

The five states with the greatest year-over-year increase in defect frequency are Wyoming, North Dakota, Mississippi, South Dakota and Montana.

The five core-based statistical areas with the largest year-over-year increase in defect frequency are Raleigh, N.C.; Birmingham, Ala.; St. Louis, Minneapolis and Jacksonville, Fla.

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